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Can Penny Stocks Make You Rich? 3 Things to Know

By Katie Brockman – Updated Sep 13, 2021 at 9:09AM

Key Points

  • Penny stocks are investments that typically trade for $5 or less per share.
  • While they are more affordable, penny stocks can be risky.
  • If you're investing on a budget, there are ways to limit your risk without breaking the bank.

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Penny stocks can be a tempting investment, but are they right for you?

Investing in the stock market can help you generate wealth that lasts a lifetime, but it can be expensive to get started. Some stocks cost hundreds or even thousands of dollars per share, and you can easily spend several thousand dollars building a diversified portfolio.

Penny stocks may seem like an affordable alternative, as these investments typically cost less than $5 per share. If you're investing on a budget, you can't beat those prices.

However, there are risks involved in buying penny stocks. If you're trying to get rich with this type of investment, there are a few things to keep in mind.

Penny sitting on a pile of assorted bills

Image source: Getty Images.

1. Penny stocks can be extremely volatile

All stocks are subject to volatility, but penny stocks are especially turbulent. The companies that issue them are generally smaller businesses that can't trade on traditional stock exchanges, and smaller organizations are often more volatile than their larger counterparts.

Penny stocks often experience extreme price swings from day to day, which can be nerve-wracking for investors. If you have a lot of money tied up in penny stocks and prices plummet overnight, you could see a serious dent in your portfolio.

2. It can be difficult to sell penny stocks

Penny stocks also don't offer as much liquidity as traditional stocks, which adds to their risk. Fewer investors are willing to buy them, so if you choose to sell your investments, you may not be able to find a buyer right away. If no one is willing to buy your shares, you'll have to hold onto them until you're able to sell.

Coupled with the fact that penny stocks are especially volatile, this lack of liquidity can be dangerous. If you're unable to sell your shares right away, the stock price could sink before you're able to offload your investment. You could end up selling for a steep discount, thus locking in your losses.

3. These stocks are inherently riskier

Volatility and liquidity aside, penny stocks simply carry higher levels of risk than traditional stocks because they're generally not from well-established companies.

It's more difficult to research the companies behind penny stocks because there may not be much (or any) publicly available information about them. Even if there is information about the organization, smaller companies may not have a long track record to examine. And buying stocks from very young organizations without a proven history of success can be a risky move.

A better alternative to penny stocks

One of the biggest appeals of penny stocks is their affordability. The good news is that there's a way to invest in big-name stocks without the high prices: fractional shares.

With fractional shares, you can buy a small slice of nearly any stock for a fraction of its listed share price. If you wanted to invest in Amazon (AMZN -0.77%), for example, but can't afford to pay more than $3,000 per share, you can buy a fractional share of the stock for as little as $1.

To make money in the stock market, you're likely better off buying strong companies and holding them for the long run rather than investing in shaky stocks simply because they're cheap. Fractional shares offer the best of both worlds, allowing you to buy solid stocks without breaking the bank.

Penny stocks' low prices can be attractive, but they're often not worth the risk. By investing in fractional shares instead, you can create a robust portfolio that will help you generate wealth over time.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Katie Brockman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. The Motley Fool has a disclosure policy.

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